Hedge funds buying into Japanese recovery

CBS.MarketWatch.com

NEW YORK (CBS.MW) -- Some U.S. hedge funds are buying into the Japanese recovery, betting its economy has bottomed out, and one manager has sold U.S. large-cap stocks as part of the shift.

If investors only pay attention to "the sell-side analysts and Western press, you would think Japan was on the verge of collapse," said Raj Gupta, who manages the Epoch Funds and G10 Macro Group.

"The sleeping giants are finally beginning to wake up and are prepared to join in the spending boom," he said, referring to consumer confidence in Japan and Europe as well.

It's been less than a year since the Asian economic crisis roiled the world's stock and credit markets, slamming the hedge funds. Yet the near 33 percent year-to-date rise in the Nikkei is proof of foreign investors' change in sentiment toward Japan, even as most commentators note that the Japanese themselves remain net sellers of Japanese equities.

Seeing green

Japan's fiscal stimulus package has sown the seeds and "the green shoots of recovery are becoming evident," Gupta told a room of fund managers at a Managed Funds Association conference in New York."It's a dangerous time to bet against the Japanese economy."

The health of the Japanese economy is the subject of great debate among economists, with many U.S. commentators skeptical about the banking sector's drag of bad loans.

"There's quite a difference of opinion about the outlook for Japan," said Josh Feinman, chief economist at Deutsche Asset Management Americas. "Asia is picking up and that should be beneficial for Japan ... yet a lot of people think the structural changes (in Japan) have a long way to go.

"Japan's economy has been doing better than it has in a year," he said. "It's a question of degree. Has it really turned the corner and is headed toward a self-sustaining recovery?"

Year-to-date, the average global hedge fund was up 10.7 percent through the end of May, according to Van Hedge Fund Advisors International.

Non-bank play

In the first quarter of this year, David Gerstenhaber, president of Argonaut Capital Management, said he began a portfolio adjustment, suspecting that "global economic growth would surprise on the upside" after a round of global central bank easings. As a result, their exposure in Japan has climbed from near zero as a percentage of net asset value to a top of 35 percent, he said.

In common stocks, Gerstenhaber looked for companies he labels part of "the new Japan." In other words, the Argonaut funds stayed clear from manufacturers and banks. Nikkei composites weren't well represented.

The funds invested in non-bank financials like Takefuji, which lends to consumers and the Shokoh Fund. Other plays include deregulation and technology, leading to telecom giant NTT
NTT, -0.80%
NTT DoCoMo majority-owned wireless subsidiary and Mitsui Petrochemical.

The Asian bet has taken Argonaut to Korea and "cheap financial assets" like Pohang Iron and Steel, a low-cost steel producer, and several Korean banks. The funds have returned 37 percent year-to-date.

AOL out of favor

Last fall, Argonaut moved into large-cap stocks and Internet stocks like America Online
aol
Cisco
CSCO, -4.02%
and MCI WorldCom
wcom
looking for the names to deliver topline growth and to absorb liquidity as the Federal Reserve pumped it into the system.

Beginning in the second quarter of this year, it was clear to Gerstenhaber that the "mania" in the Internet stocks "was not justified by the underlying fundamentals." Moreover, a stuffed, Net-heavy IPO calendar was raising concerns "at the same time of renewed global growth." As a result, Argonaut began selling some U.S. holdings at the end of the first quarter and "aggressively in the second quarter," he said.

He expects a European upturn "to be more muted," and is invested in Nokia
nok
and Mannesmann and Vodafone
VOD, -1.55%
among others.

Doubts remain

Not all fund managers are keen on Japan, noted George Van, chairman of the fund advisor group.

"There's still a lot of caution, even if there is a glimmer of optimism. Some of them got burned on the yen-carry trade and that hurt the macros," Van said.

Some of the U.S. funds are linking forces with Japanese banks and are getting directly into restructuring by buying bad debt at a discount.

With a yen-carry trade, investors take advantage of near-zero short-term rates in Japan by borrowing yen and buying higher-yielding assets like Treasurys. Many of those trades were "unwound" in June when the dollar and Treasurys fell.

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